Proposition 98 and the Budget — Who’s Right?

A central part of this year’s budget negotiations is funding for schools and the intricate workings of Proposition 98, the voter-approved 1988 initiative whose formulas dictate the level of state financial support for public education. 

Gov. Schwarzenegger is proposing schools receive $6.6 billion less during the current school year –  $2.5 billion in actual cuts plus $4.5 billion in deferrals and transfers the administration says are aimed at not harming classroom instruction. 

But state education interests are saying Schwarzenegger is trying to short schools at least another $7.2 billion in future payments by misinterpreting the three funding formulas – or tests — of Proposition 98.  

Schwarzenegger says there is no constitutional requirement to pay the $7.2 billion. 

“We don’t think this is a gray area,” H.D. Palmer, spokesman for Schwarzenegger’s finance department, told the San Francisco Chronicle.  

Repayment of past spending reductions is a centerpiece of Proposition 98. When state revenues fall or grow more slowly so does the state’s required financial commitment to public schools and community colleges. 

During revenue low times, the level of state school spending is usually dictated by Proposition 98’s Test 3 which allows the state’s base funding level to fall but requires that in years when state revenue growth exceeds that of personal income, 50 cents of every dollar above that threshold must be used to restore schools to the funding level they should have been at. 

In other words, in lean economic times schools would receive less than the minimum spending target set by Proposition 98. But the state would keep track of that amount and, in healthier economic years, accelerate payments to schools to return to that target. 

That repayment amount is called the maintenance factor. Prior to the current fiscal year, the state owed schools $1.3 billion in maintenance factor payments. 

Test 2 is used in times with normal revenue growth. It increases the level of school funding based on prior-year funding by growth in attendance and per capita personal income. It’s the most generous of the tests.

Test 3 and Test 2 are only supposed to be used if they give schools more money than Test 1 which sets a minimum guarantee of roughly 40 percent of the state’s general fund revenue for schools.  

Under Schwarzenegger’s calculations, this year Test 1 would give schools $51.5 billion and Test 3, $60 million less. Test 2, which sets the spending target, is $58.7 billion, a difference of $7.2 billion between it and Test 1. 

Since the state’s revenues are definitely not growing more than per capita personal income growth – there’s a $41 billion revenue shortfall – Test 2 isn’t operative and Test 3 is less generous than Test 1 so school funding this year is set by Test 1. 

Test 1 has never bested Test 3 in Proposition 98’s 20-year life. 

Schwarzenegger contends that because Proposition 98, which can be found in Article XVI, Section 8 of the state constitution, is silent on what to do in this unique situation. In the constitution, Test 3 is the only test for which a maintenance factor is mentioned. 

Schwarzenegger then says that since there is no constitutional requirement under Test 1 to build back school spending to the Test 2 target of $58.7 billion that $7.2 billion difference is not an obligation. 

This has a significant effect on the budget the GOP governor is proposing for the fiscal year beginning July 1. 

Schwarzenegger’s budget fix is premised on increasing taxes $8 billion in the current fiscal year, which would cause state revenue growth to exceed growth in per capita personal income. That would increase the amount schools would get under Test 3, causing 50 cents of each new dollar above the growth in personal income to go to schools to more quickly bring it back to its $60.1 target. 

That wouldn’t happen under the governor’s interpretation of Proposition 98, allowing more new revenue to flow into other state programs paid by general fund. 

The governor’s Department of Finance projects the state operating on Test 1 for the next several fiscal years, Palmer said. 

Educators see things differently – the payback provisions of Proposition 98 still apply, they argue.  

They are already criticizing the governor’s proposal, saying it is a potential $7.2 billion liability that could damage the state’s ability to pay its debts. They are marshaling forces to convince lawmakers that approving the governor’s proposal would result in a permanent reduction in potential school spending, which, they note, already ranks 47^th in the nation on a per-pupil basis. 

Some educators fear lawmakers may side with the governor to score some temporary budget savings in the belief that several years hence, educators would prevail in court. 

While that result is far less than certain, the state has suffered several costly legal losses to the California Teachers Association in the past. 

Recently, the teachers association filed an initiative to increase the sales tax by 1 cent and dedicate the $5 billion to $6 billion generated annually to public schools and community colleges. 

These sales tax revenues would be in addition to the money public schools receive from Proposition 98. 

The Public School Investment and Accountability Act contemplates the tax increase take effect January 1, 2010 which means voters would need to approve the measure at a special election either in June or November of this year. No special election has yet been called. 

It’s unclear how the initiative fits into the budget mix. 

In a plan vetoed by Schwarzenegger January 6, Democratic lawmakers proposed a three-fourths of a cent increase in the sales tax. 

Schwarzenegger advocates a three-year temporary 1.5-cent increase in the sales tax, beginning March 2009. He also favors expanding the sales tax to include some services such as veterinary care, amusement park admissions and golf. 

If the budget deal contains a sizable sales tax increase, the odds of an additional sales tax boost winning at the ballot diminish — even for something popular with the electorate like schools. 

Under that situation, the initiative would likely be withdrawn. 

However, should the budget contain the $7 billion reduction in school spending, its likely the teachers association and its education allies would launch an even broader political jihad against Schwarzenegger than the one they’ve begun. 

Besides a public awareness campaign cataloguing the damage caused by the reductions, educators would likely work to defeat two other ballot measures slated to appear on a special election ballot this year: approval to use future lottery sales to borrow $5 billion today and create a second rainy day account into which a percentage of state revenues would be automatically deposited.  

Schwarzenegger’s school funding proposal also is a tacit indicator of the confidence his administration places in its current revenue estimates. 

Under Test 1, the GOP governor proposes $51.5 billion in Proposition 98 spending. The funding level dictated by Test 3 is only $60 million less, a razor-thin margin subject to many variables. 

For instance, should local property tax revenues come in at less-than-anticipated levels – a distinct possibility given the meltdown of the housing industry and tumbling home values – that would require the state to increase its share of school costs. 

Substantially increased state school spending would likely make Test 3 the more generous formula, a test in which there is no ambiguity over the state’s repayment requirement. 

Of the nearly $16 billion in local property taxes that go to schools, estimates need only be off by $61 million to kick in Test 3 and its maintenance factor. 

In its assessment of the governor’s budget plan, the Legislative Analyst says it’s realistic but has “downside risks from further deterioration of the economy and state revenues, and from costs that the state is likely to incur but are not included in the Governor’s budget.” 

If revenues came in lower than expected that would widen the thin $60 million margin separating the two tests, maintaining the future budget savings Test 1 offers. 

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